Matt Yglesias has suggested, many times, that there are no downsides to a “currency war”. Here is the most recent example. Now Paul Krugman and Greg Ip are on board. The basic argument is as follows: much of the world needs more monetary stimulus, and currency wars are a form of quasi-coordinated monetary stimulus. Hence, if we start a currency war we’ll all get monetary stimulus and a bunch of national economies will improve simultaneously. According to this view, currency wars not only are not negative-sum (the Barry Eichengreen finding concerning the 1930s devaluations), they aren't even neutral; they're positive-sum.

The problem with this way of thinking is common in a lot of commentary about economics: it refers to global dynamics purely in terms of local effects (if it refers to global dynamics at all). But global dynamics have global effects.

That is, this is a conceptual problem. If we think of the global economy as a single system comprised of many different interdependent units, then we would ask what the effect of a currency war would be on the system. There is no reason to think it would be the same everywhere. At the very least, we should think that parts of the system which control systemically important currencies would react different than parts of the system which do not. If we conceptualize the global economy in terms of the units, and not the interdependencies between them, then we end up only caring about what happens in the U.S. and EU.

Thinking in terms of systemic, rather than just local effects, leads us to the conclusion that there may some significant downsides to a currency war, although they are likely not to be primarily in the U.S. There is mounting evidence suggesting that the several food crises since 2007 have been a result of ever-expansionary Federal Reserve policy. For example, a 2009 paper suggested:

While the market dynamics during this period are still not well understood, a combination of macroeconomic factors such as the depreciation of the dollar and lower interest rates in the United States...

Krugman considered this view in 2011, and rejected it. He blamed the food crises on climate change. While that may be a contributing factor -- and noting that boosting demand in industrialized societies would only increase carbon emissions, and thus exacerbate the problem -- the role of the Federal Reserve cannot be dismissed so easily:

That's a pretty close association, and even more impressive as it tracks non-linearly.

Released in July 2008, What’s Driving Food Prices? identified three major drivers of prices—depreciation of the U.S. dollar, changes in production and consumption, and growth in biofuels production.

More recently, David Leblang of the University of Virginia has presented a conference paper arguing that, through the channel of increased commodity prices, Federal Reserve interventions did have a role in the onset of the Arab Spring, via the mechanism of commodity price volatility. I can't find an online version of the paper, but he makes a persuasive argument.

This follows a lot of previous literature suggesting that commodity price volatility is associated with conflict in less-developed areas, and the Fed actions are associated with commodity price movements. In other words, the theoretical story is pretty sound. All you have to do is connect the dots. To connect the dots, you need to think systemically.

So this is the potential downside of a currency war: monetary stimulus in the countries which control major currencies, and volatility everywhere else. This is why the term "currency war" was coined by a Brazilian (and reiterated by a Russian), not a German. In the worst case scenario relatively rich people in what used to be called the global North get richer, while relatively poor people in the global South get poorer, and possible even face political instability and violence.

6
comments:

This post ignores that the systematic effects can be mitigated by national governments. We have to understand what options are available to governments and why they don't take specific policy steps to mitigate the harm. In this case domestic political economy is obviously important. I don't really know anything about Brazil, but when I hear Brazilians complain about currency wars I immediately think it's about promoting their manufacturing sector. Surely they benefited in some way from increasing commodity prices, being a commodity exporter. Second, we don't necessarily know how rising food prices affect the global poor. Perhaps bad for people living in cities but for those in rural areas with the ability to produce their own food less so.

Theo - your question does nothing but buttress Kindred's main point - that "currency wars" are not positive-sum, and that the effects of QE/central bank interventions do have ramifications outside of the rich white countries club (in this case, yes, the "dollar" price of food).

That, obviously, is a normative question. The point I'm trying to make (as Anon noted) is that not everyone would benefit. Yglesias and Krugman and others are ignoring that.

Vladimir,

Some national governments will have the appropriate policy tools to deal with this. For example, countries with external surpluses and lots of foreign exchange can burn through some of it. This is what Saudi Arabia did during the Arab Spring: they essentially bribed the country to not have a revolution. But not every country is in a position to do that.

You are also correct that certain segments within societies will benefit while others suffer. But this is not necessarily a good thing from the perspective of political stability.

I saw that. Should have linked to it in the original post, as it is a good example.

The point is, when major economies (esp the US) embark on significant monetary policy changes the international effect is profound. The 1980s "Volcker recession" caused by jacking up interest rates also caused a series of financial crises in Latin America. There was a significant monetary tightening in the US right before the E Asian currency crises in the 1990s too, although the causal relationship is a bit less clear there.